Government intervention

Question 1

How could the state provide a merit good/good with positive externalities e.g. helathcare

Answer 1

MPB = actual demand MSB = correct demand if private benefits were accounted for i.e. full information provided

State chooses to supply healthcare at allocatively efficient level of output

State supply curve is vertical at Q*

Reduces the price to P*

Resolves problem

Question 2

What is the problem with UK health provision

Answer 2

Price = 0

QD > Q* —> excess demand

Question 3

How do subsidies work for a good with a positive consumption externality

Answer 3

MPC curve shifts right

Subsidy per unit should be equal to the MEB

Results in lower price and QD increases to Q*

Question 4

How do subsidies work for a good with a positive production externalities

Answer 4

MPC curve falls to MSC curve

Subsidy per unit is equal to MEB

Price falls to P*

QD rises to Q*

Question 5

What are the limitations of using subsidies

Answer 5

Whether firms pass on the subsidies in the form of lower prices —> may decide to add subsidy to profit

PED

Size of subsidy —> small subsidy won’t shift MPC curve far enough to right

Question 6

What are the advantages of using subsidies

Answer 6

Encourages MNCs to locate in country with subsidies which leads to higher GDP and employment

Encourages firms to increase output which may lead to firms employing more people

Necessities —> low income will benefit the most

Question 7

What are the disadvantages of using subsidies

Answer 7

Cost the government money —> opportunity cost

Encourages productive inefficiency —> firms not encouraged to cut unit costs

Question 8

How do taxes work for a negative production externality

Answer 8

MPC curve must increase by the value of external costs

Tax should be equal to value of external costs at Q*

Decreases QD from Qa to Q*

Externality internalised

Question 9

How do taxes work for a negative consumption externality in

Answer 9

MPC curve must increase by value of external costs

Tax should be equal to value of external costs at Q* shifting the MPC curve upward

Increases price to P*

Question 10

Limitations of using tax

Answer 10

Firm may accept a drop in profit —> MPC curve won’t shift

Size of tax —> tax too small, MPC curve will not rise by enough to reach social optimum

Value of tax should be equal to external cost —> difficult to find a true monetary value for external cost

Question 11

What are the advantages of using tax

Answer 11

Tax revenue —> can be used to further reduce output e.g. green taxes used to invest into cleaner technology

Market based policy —> allow individual to make decision to buy the higher priced good —> requires little monitoring Pollution taxes —> incentivises firms to find greener methods of production

Question 12

What are the disadvantages of using tax

Answer 12

Regressive

Discourage MNCs from setting up

Smaller firms struggle to pay taxes —> could go out of business

Question 13

How do regulations work with a negative production externality

Answer 13

Approach 1 —> gov set a cap on the level of g/s the firm can produce equating to Q*

Firm reduce their output to Q*

Approach 2 —> introduce regulations increasing cost —> reduce supply (shift)

Approach 3 —> introduce regulations to engage in activity to reduce negative externalities

Question 14

What are the limitations of using regulations

Answer 14

Only optimal if cost of regulation is less than the benefit to society

Fines need to be large enough to persuade firms to comply with the regulation Regulation needs to be multilateral otherwise firms can relocate avoiding the regulation

Government agency needs to be effective at monitoring compliance

Depends on the level which the regulation is set, cap needs to be at Q* output

Question 15

What are the advantages of using regulations

Answer 15

Regulations can be easily amended —> allow authorities to change the cap until they reach the socially optimum level

Question 16

What are the disadvantages of using regulations

Answer 16

Financial cost of setting up agency

Opportunity cost present

Black markets created so firms can avoid costs of complying with regulation

Firms may find their costs rise too much so can no longer make profit

Mobile firms can relocate to other countries that don’t have regulations

Question 17

Define minimum price

Answer 17

A price which is the lowest firms can charge

Question 18

What are the advantages of minimum price schemes

Answer 18

Increases producer surplus

Lowers QD —> increase social benefit/reduce external costs

Question 19

What are the disadvantages of minimum price schemes

Answer 19

Decreases consumer surplus

Creates excess supply (bought by gov)

Creates black market Ineffective if PED of good is inelastic

Question 20

Define subsidy

Answer 20

Amount of money paid by the government to a firm for every unit of output that it produces

Question 21

Define regulation

Answer 21

Rules laid down by the gov in order to affect the behaviour that leads to market failure

Question 22

Define maximum prices

Answer 22

A price above which firms cannot charge

Question 23

What are the advantages of maximum price schemes

Answer 23

Increases consumer surplus Benefits low income groups

Question 24

What are the disadvantages of maximum price schemes

Answer 24

Increases QD producing external costs Producer surplus decreases Lower profit for suppliers Creates excess demand